Is it appropriate to combine service charge and ground rent arrears?

When acting for an RMC or Right to Manage company, managing agents will often be told by the landlord of the development and/or its legal advisers to allow them deal with the service charge arrears.

The benefits of such an approach are clear from the ground rent owner’s perspective but is it in the best interests of the management company, leaseholders and the block?

The trend for combining ground rent and service charge arrears is now common – but all parties should proceed with caution, as Clare Brady, MD of property management experts Brady Solicitors, explains.

With ground rent recovery increasingly in the spotlight, both managing agents and freeholders must take care to ensure recovery procedures are legal, in line with the terms of the lease and – importantly -in the best interests of the management company and the leasehold clients.

When assessing whether or not to allow service charge arrears to be transferred over to the Freeholder and/or it’s agents/advisors, we recommend taking into account the following considerations…

Brady Solicitors set out the key considerations for both managing agents and RMC directors when facing a request to combine the service charge arrears with the ground rent debt.

To whom is the service charge payable?

The lease will dictate to whom the service charge is payable. Check the lease – who has the benefit of the service charge clause? Sometime it is the management company, sometimes it is the freeholder, and occasionally it is both.

Who is legally entitled to bring a service charge claim?

It cannot always be assumed it is the freeholder. In those cases where the RMC has the sole right to claim service charges under the lease, the freeholder will not be legally entitled to do so and vice versa. Where the lease states that the service charge is payable to both the landlord and the RMC, there is a choice in who collects the Service charge.

Where the RMC has the right to demand – and recover – the service charge arrears, combining these arrears with the ground rent can cause problems for a managing agent tasked with collecting service charge arrears as effectively possible.

Who issued the service charge invoices?

Consider who issued the actual service charge invoices that have led to the arrears situation. In practice, the freeholder has often had no dealings with the service charge collection, and has not issued any service charge demands. The cause of action therefore lies with the managing agent on behalf of the RMC and the managing agent is not legally obliged to instruct the freeholder’s legal team to recover the arrears.

Has the freeholder sanctioned the joining of the claims?

Managing agents are sometimes told that the landlord wishes the service charge and ground rent to be joined, where it is in fact the ground rent managers who have provided the instruction to combine the claims and not the Freehold company itself.

What are the forfeiture provisions?

The forfeiture provisions of the lease must also be reviewed. Whilst landlords often have the sole right under the terms of the lease, to forfeit the lease, this is not always the case. Some modern leases provide the right to the RMC to forfeit in the event of a breach.

Who has the reversionary interest?

To state the obvious, the freeholder is the company or individual with the legal title of the freehold. The reversionary interest entitles the owner of that interest to the leasehold title on forfeiture. Less obviously, the reversionary interest does not always belong to the freeholder.

A typical example of a “hidden” reversionary interest is a head lease. Head leases are often created where an RMC takes the freehold from a developer once the development is completed.

A head lease is a lease granted by the freeholder to the head lessee transferring some or all of the freeholder rights (often including the right to reversion on forfeiture) under the leases of the estate to the head lessee.

Are you acting in your client’s best interests?

Last on the list but the biggest consideration of all is whether or not you are acting in your client’s best interest by combining the arrears. Consider to whom duties are owed: Who is the client? This is much clearer where instructed by the freeholder or by the party with the reversionary interest in the property such as the head lessee. If however, you are instructed on behalf of an RMC or RTM company with no freehold title nor reversionary interest, you must take care if asked to act on both the ground rent and service charge. For example, when collecting areas how will any part payment of debt be allocated first – is it against the ground rent or the service charge? What if the case proceeds to forfeiture – will the Freeholder sell the property? If it does, will it pay the service charge debts from the proceeds?

To ensure your clients’ interests are protected, and to ensure that the correct party is bringing the claim, consider the following points:

Do your Terms of Appointment allow you to collect Service charges on behalf of your client?

Have you invoiced the service charges in accordance with that authority?

Does the management company have the reversionary interest in the freehold?

Does the management company have the right to collect the service charges and/ or forfeit the lease?

Does the freeholder have any right to collect the service charge under the lease?

Could the transfer of the claim to the freeholder prejudice the managing company in any way or be viewed as an unfair practice as by the freeholder?

Before combining service charge and ground rent arrears, all relevant points should be considered and both parties advised properly.

Where legal advisers act for both the landlord and the RMC directors they must consider the implications of combining the debt and ensure that there is neither conflict of interest nor the potential for a future dispute between RMC and landlord.

From a managing agent perspective, you need to take care that you are not being led by the freeholder’s agenda, rather than acting in the best interests of your RMC client.

The most sensible option is to consider the factors mentioned above and, if necessary, keep service charge recovery separate from the ground rent arrears. Brady Solicitors can talk you through any potential conflict of interest.

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